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Wed Feb 8 11:35:12 PST 2006

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AMERICA'S ECONOMY
Feb 7th 2006  

President George Bush has proposed a $2.7 trillion budget for the 2007
fiscal year. After narrowing in 2005, America's budget deficit is once
again expanding, thanks to heavy spending on disaster relief and the
war in Iraq. With token spending cuts, the administration is trying to
claim the mantle of fiscal responsibility, even as it pushes for
increased defence spending and an extension of Mr Bush's budget-busting
tax cuts

POLITICAL speech is always full of slippery locutions, but George
Bush's state-of-the-union address last week may have set a new standard
for involuted meaning when he urged Congress to "act responsibly, and
make the tax cuts permanent". At that time, the official White House
projection of the budget deficit for the 2006 fiscal year was $341
billion, a substantial portion of which could have been erased by
rolling back the tax cuts so dear to Mr Bush's heart.  On Monday
February 6th, the use of the word "responsibly" suddenly looked even
more idiosyncratic, as the administration released a $2.7 trillion
proposed budget, and announced that the 2006 deficit projection had
grown to $423 billion, or 3.2% of America's GDP.

The Bush administration claims it is trying to reduce spending to match
the hefty tax cuts the president passed during his first term. Aside
from the programmes loosely associated with the "war on
terror"--defence, diplomacy, homeland security and veterans
affairs--discretionary spending (the section of the budget that is
allocated directly by Congress every year) is actually scheduled to
fall in the 2007 fiscal year by roughly $8 billion.

The president's critics retort that such fiddling is the fiscal
equivalent of rearranging the deck chairs on the Titanic. After
shrinking surprisingly quickly in the 2005 fiscal year, the budget
deficit is once again expanding, thanks to big bills for the wars in
Iraq and Afghanistan and the clean-up after Hurricane Katrina. If a
Republican Congress and president can only manage to cut their least
favourite programmes by a paltry amount when faced with a budget
deficit soaring towards the half-trillion mark, then it is time to
concede defeat and raise taxes.

Mr Bush's Democratic critics do not, of course, want him to trim
spending at all. They squeal that the president's proposed cuts to
domestic programmes like Medicaid and Medicare, which provide health
care to the poor and elderly respectively, are immoral in the face of
tax cuts that have mostly benefited wealthier Americans. But even many
of Mr Bush's natural political allies are unenthused. The health-care
cuts, after all, are projected to save only $3.2 billion next year, a
drop in America's sea of red ink.

Moreover, all this assumes that Congress will actually pass all of Mr
Bush's proposed spending cuts into law. Given that this is an election
year--all of the House of Representatives, and one-third of the Senate,
will be asking voters to return them to office in November--it will be
hard to persuade either chamber to make even token cuts to domestic
spending.

And even if Congress does oblige, the budget projections require some
rather heroic assumptions about the future course of spending. Military
spending is currently supposed to fall off sharply after 2007, the last
year in which extra spending for Iraq and Afghanistan is budgeted. This
seems hugely optimistic, considering the problems still faced in both
countries. 

The projections also receive a boost from assuming that America's tax
code will not change much in coming years. The Office of Management and
Budget has assumed no alteration to the Alternative Minimum Tax (AMT),
a special levy designed to catch wealthy people who had moved most of
their income out of the taxman's reach. Thanks to bracket creep, the
AMT will soon threaten to catch the middle class in its net; most
experts agree that it will probably be necessary to reform it soon, to
refocus it on rich tax avoiders.

WE ARE THE WORLD
America's gigantic budget deficit is not merely a concern for the
generation of Americans currently in nappies, who are likely to be on
the hook when the debt comes due. Many economists worry that the
growing fiscal gap is one of the main forces driving the expansion of
America's current-account deficit, which was over 6% in the third
quarter of 2005, the most recent for which figures are available. And
that current-account deficit is a big global problem.

Since the worldwide economic slowdown of 2001, America's gluttonous
appetite for imports has been one of the mainstays of the global
economy, allowing other countries to export their way back to a modicum
of economic health. China, in particular, has deliberately fuelled its
economic growth by keeping its currency cheap against the dollar,
making its goods attractive to American consumers.

But Americans are borrowing staggering sums abroad to support their
import habit. The federal budget deficit, economists worry, is
essentially being financed overseas, particularly by central banks like
China's, who buy dollars to raise their price against the local
currency, and then park those dollars in US Treasuries. Should the
banks' appetite for American debt wane, American borrowers, including
the government, would face sharply higher interest rates. This would be
a nasty shock not only to the American economy, but to all those
countries that depend on American demand to keep their own economies
rolling along. 

Many economists are urging the government to put the books in order now
so as to lessen the potential blow of a disorderly correction. Even
those who are not convinced that federal borrowing is driving America's
current-account deficit wider (such as Ben Bernanke, who has just
replaced Alan Greenspan at the head of the Federal Reserve) are calling
on the government to get its finances under control in order to improve
the national savings rate and lower the bill that Congress hands to
future generations.

But not even rescinding all of Mr Bush's tax cuts would close the gap;
much of the budget deficit is the result of new spending, on expensive
projects, such as the Iraq war and a new prescription-drug benefit for
Medicare, and the unexpected decline in tax revenues that occurred
after the stockmarket bubble crashed. Bringing the budget back to
balance will require a politically unpalatable combination of tax
increases and spending cuts. 

But for all their rhetoric, so far the Republicans have barely touched
domestic discretionary spending. Even if they did find the gumption to
make real cuts, this would be insufficient, since mandatory
spending--which covers things like Medicare, Social Security and
interest on the national debt--accounts for the lion's share of federal
outlays. That share will only grow as America piles up debt and the
baby-boom generation retires. Mr Bush's modest changes to Medicare
rules are certainly not enough to alter that ruthless arithmetic. But
neither the Republicans nor the Democrats have the stomach for any
serious reforms to the popular programme--most of the political debate
over Medicare has focused on how the government can spend more to help
the elderly buy drugs. Perhaps Mr Bush's successors will be able to
find a creative new definition of "bankrupt".

See this article with graphics and related items at http://www.economist.com/agenda/displaystory.cfm?story_id=5489574&fsrc=nwl

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